How D&O Insurance Factors into M&A Transactions
by Kara Altenbaumer-Price
With dozens of moving parts, mountains of documents in due diligence, and thousands of hour of legal work, the role of insurance in planning for negotiating and securing M&A transactions may often get lost. However, this critical part of any M&A transaction can both help close deals and protect the parties involved to ensure a smoother road after the closing.
Planning for Tail Insurance
In a typical M&A transaction, the seller company will cease to exist in whole or in part upon closing. Its D&O insurance policy will also cease to exist in its current form. However, the liabilities of the selling entity will not cease, particularly those liabilities arising from the decision to enter the deal. A necessary part of the M&A process must be the consideration of tail—or runoff—insurance for the selling entity and its officers and directors. Tail insurance provides coverage for wrongful acts that occurred prior to the closing—whether they are related to the closing or not—but that have not yet been brought as claims. It is important to select a policy term that is longer than the statute of limitations for any potential claims; most entities purchase six-year tail policies to be well outside of five-year statutes of limitations that exist under certain federal statutes.
Additionally, steps may need to be taken to ensure the newly-acquired entity is covered under the buyer’s D&O policy for wrongful acts that occur after the deal close. While this may be automatic for acquisitions that are under a certain threshold in comparison to the market cap of the buyer, larger acquisitions may require the new subsidiary to be formally added to the policy or for additional underwriting and premiums to be paid.
Use of Reps & Warranties Insurance to Close a Deal
An essential part of any M&A negotiation is the representations and warranties the parties provide in the course of the deal. It is no secret that problems with these representations and warranties and indemnity requirements can end a deal. Reps & Warranties Insurance can create a necessary bridge between a large escrow and broad reps and warranties desired by a buyer and the small escrow and limited reps and warranties desired by a seller and enable deal closure.
For buyers, Reps and Warranties Insurance can be used to extend indemnification from the seller in a deal either longer than any escrow deadlines or above any escrow amounts. It can help provide assurance to a buyer that someone will be there should issues be discovered after closing and gives buyers more time to detect and report problems after purchase. For sellers, Reps and Warranties Insurance can enable a seller to exit the deal sooner and with more clarity by freeing up cash that might otherwise be tied up in escrow.
Bump-up Claims and D&O Insurance
Statistics show that roughly 50 percent of all M&A transactions result in litigation. The percentage is even greater for large deals and those involving public companies. While some of these suits seek to stop the deal, many demand the deal be sweetened. These suits are often called “bump up” claims because they are designed to “bump up” the price of shares purchased from the selling company’s shareholders by the buyer entity. While defense of these suits is generally covered by D&O insurance policies, the increased consideration—or “bump up”—is usually excluded from D&O coverage. While claims against officers and directors for breach of fiduciary duty in relation to the deal or deal negotiations are not technically excluded by a “bump up” exclusion, insureds are often hard-pressed to win an argument with a carrier that the settlement was not an increased consideration and thus uncovered.
Because the frequency of M&A litigation has risen so dramatically and because there has been little dispute that defense costs are covered for such suits, D&O carriers have been inserting separate M&A deductibles into many company’s 2012 and 2013 insurance renewals. These deductibles are often substantially higher than the standard deductible under the policy and provide that if a claim relates to an M&A transaction, an alternate higher deductible will apply. While it may be tough to avoid a separate M&A deductible, companies should review such provisions carefully to ensure that the deductibles apply only to “bump up” and similar claims and do not serve to exclude other types of litigation that can arise in relation to the deal, such as for integration issues.
Kara Altenbaumer-Price is Vice President and Management & Professional Liability Counsel at USI Insurance Services. She can be reached at firstname.lastname@example.org.